Box B: Households' Mortgage Prepayment Buffers

In Australia, households often choose to
pay down their mortgage more quickly than
required. Various data sources suggest that
around half of borrowers are ahead of schedule
on their mortgage. In this way, many households
have a buffer that they could temporarily
draw on to stay current on their loan repayments
if their incomes were to fall. The share
of Australian households paying their mortgage
ahead of schedule is high compared with many
other countries, though the available evidence
suggests it is broadly similar to Canada.

In aggregate, the stock of Australian households'
prepayment buffers is estimated to be equivalent
to over 10 per cent of the outstanding
stock of housing loans (Graph B1). This
includes balances in mortgage offset and
redraw facilities. Flows into these accounts
include regular excess repayments and one-off
excess repayments paid out of salary bonuses
or other irregular income. The stock of
prepayments has risen recently, in part because
most borrowers do not change their regular
repayment amounts when interest rates fall.
Some borrowers have also been choosing to
make very large prepayments recently; according
to the latest HILDA Survey, the share of
indebted households who made substantial
principal repayments on their mortgage (of
$25,000 or more over the year) was
significantly higher in 2010 (22 per cent)
than the average between 2002 and 2007 (15 per cent).[1]

Measured a different way, in aggregate,
indebted households' mortgage prepayment
buffers are estimated to be equivalent to
around 1½ years of scheduled repayments
(principal plus interest) based on current
interest rates. While this average figure
is boosted by a group of borrowers that are
significantly ahead of schedule – liaison
with the major banks suggests that around
15 per cent of borrowers are ahead by two
years or more – many borrowers still have
sizeable buffers. Of those borrowers that
are ahead on their mortgage: around 45 per
cent are estimated to have a buffer of up
to six months; 15 per cent have a buffer
of between six months and a year; and over
40 per cent have a buffer greater than
one year's repayments (Graph B2).

Data from the HILDA Survey suggest that
households with large mortgage buffers tend
to be older and have higher incomes, which
is consistent with these households having
had more time and/or income to accumulate
such buffers (Graph B3). Borrowers that
have small or no buffers tend to be younger
or have more recently taken out their loan.
Even among these latter groups, however,
just over half of borrowers are reported
to be ahead of schedule on their repayments.

The bulk of households that are not ahead
of schedule on their mortgage are not in
financial stress; roughly half of indebted
households are paying their mortgages on
schedule, with only a very small share of
borrowers in arrears. Some borrowers may
have chosen to take out loan products that
discourage excess repayments but nonetheless
suit the borrowers' circumstances.
For example, prepayments are less common
on fixed-rate loans because these loans typically
involve fees on prepayments above a certain
threshold. In contrast, variable-rate loans
– which are the bulk of housing loans in
Australia – do not generally involve prepayment
penalties and therefore show higher rates
of excess repayment. Decisions to prepay
may also be influenced by tax incentives.
Owner-occupiers have an incentive to pay
down their mortgage ahead of schedule as
their interest payments are not tax deductible:
in effect, the post-tax return to prepaying
these loans equals the mortgage rate. Investors,
by contrast, do not have the same incentive
to make excess repayments given they can
negatively gear their property. Consistent
with this, over half of owner-occupiers are
estimated to be ahead on their mortgage compared
with less than 40 per cent of investors,
and, of those that are ahead, owner-occupiers
tend to have larger buffers.

The share of owner-occupier households that
could be considered to be most vulnerable,
that is, with both high debt-servicing ratios
(DSRs) and high loan-to-valuation ratios
(LVRs), was quite low at around 2½ per cent
in 2010 according to data from the latest
HILDA Survey (Graph B4). The measure of debt
servicing used here covers actual repayments
made by households and includes excess repayments;
more than one-third of these households are
ahead of schedule on their mortgage. For
these borrowers, this would suggest that
their high DSRs are largely voluntary and
that they are therefore less vulnerable to
falling into stress.

Footnote

See RBA (2012), ‘Box B: Home Mortgage
Debt: Recent Insights from the HILDA Survey’, Financial Stability Review, March,
pp 53–56. Generally, the HILDA Survey interviews
the same set of individuals each year, mainly
between August and November, with the latest
published results being for 2010. It therefore
makes it possible to trace individual changes
in housing debt over the past decade.